Update: This amendment passed by voice vote.

Frankly, I just don't understand foreign currency swaps. It's above my pay grade.

Yet, we have an amendment, by Rep. Alan Grayson and Ron Paul, to restrict the Federal Reserve on issuing foreign currency swaps.

The amendment restricts the Federal Reserve by requiring five Federal Reserve members of the board of Governors approve as well as the U.S. Treasury Secretary.

The Bank of International Settlements, Switzerland, has written a paper on the U.S. dollar shortage and the international policy response, from what happened by the fall of 2008. Below is a graph of the sudden increased foreign currency swaps issued by the Federal Reserve:

^{Src: Zero Hedge, click on image to enlarge}

The global financial crisis has shown just how unstable banks’ sources of funding can become. Throughout the crisis, but particularly following the collapse of Lehman Brothers in September 2008, many banks faced severe difficulties securing short-term US dollar funding.
In response, central banks around the world adopted extraordinary policy measures, including international swap arrangements with the US Federal Reserve, to enable them to provide US dollars to commercial banks in their respective jurisdictions.

What happened? It seems banking is international and globally deregulated. Remember, "foreign" claims is in part, U.S. claims or dollar claims from the BIS paper terminology.

The origins of the US dollar shortage during the crisis are linked to the expansion since 2000 in banks’ international balance sheets. The outstanding stock of banks’ foreign claims grew from $10 trillion at the beginning of 2000 to $34 trillion by end-2007, a significant expansion even when scaled by global economic activity. The year-on-year growth in foreign claims approached 30% by mid-2007, up from around 10% in 2001. This acceleration took place during a period of financial innovation, which included the emergence of structured finance, the spread of “universal banking”, which combines commercial and investment banking and proprietary trading activities, and significant growth in the hedge fund industry to which banks offer prime brokerage and other services.

It seems banks invest in one currency but fund non-bank assets in another, mainly U.S. dollars.

It seems EU banks went long on the dollar as an investment and funded this gamble with their own domestic currency.

When the crisis hit, these European banks has all sorts of U.S. dollar dominated investments where the underlying assets...tanked. Then, Lehman Brothers failed and we had a international run on the banks. Seems European banks couldn't dump off their derivatives and needed more U.S. dollars to prop it all up.

So, by the Federal Reserve issuing foreign currency swaps allowed European banks to get a hold of the U.S. dollars they needed to prop up their worthless derivatives instead of dumping these structured finance debacles onto the open market and taking the loss.

Here is the major issue:

In providing US dollars on a global scale, the Federal Reserve effectively engaged in international lending of last resort. The swap network can be understood as a mechanism by which the Federal Reserve extends loans, collateralised by foreign currencies, to other central banks, which in turn make these funds available through US dollar auctions in their respective jurisdictions.

This made US dollar liquidity accessible to commercial banks around the world, including those that have no US subsidiaries or insufficient eligible collateral to borrow directly from the Federal Reserve System.

This in effect, kept the U.S. dollar value low.

A concluding remark by BIS:

The recent financial crisis has highlighted just how little is known about the structure of banks’ international balance sheets and their interconnectedness.

Get that? They, these experts on international finance, have no clue, no idea on the contagion of international finance and banking.

BIS also notes that thinking in terms of national boundaries for international finance is a huge mistake. One cannot determine the risks by these methods today. One must look at the overall balance sheets of the largest financial institutions.

This is true on a host of economic indicators inside the U.S. We are often without information on the effects of globalization, due to some illusion that the U.S. domestic economy is reasonably self-contained.

Zero Hedge wrote up an analysis on the same BIS paper:

What is notable from the above table is just how massive foreign banks' USD-funded positions are, especially when viewed from the perspective of various GDP numbers. The 6 countries that make up the core of the Eurozone all have foreign dollar denominated claims which are well over 100% of their respective GDPs! These countries took on an amount of Dollar exposure that would take on a country's entire GDP to fund and then some.

The fact that they have done so with the complicity of the Federal Reserve is staggering and a clarion call for a global risk regulator which is distinctly separate from the US Fed, which prompted this intractable risk taking in the first place.

On this point, I can agree. It's clear we need a better understanding on global systemic risk. Look at the experts. They don't even have a clear idea what's really going on!

Here was the upper bound risk at one point:

If we assume that these banks’ liabilities to money market funds (roughly $1 trillion, Baba et al (2009)) are also short-term liabilities, then the estimate of their US dollar funding gap in mid-2007 would be $2.0–2.2 trillion. Were all liabilities to non-banks treated as short-term funding, the upper-bound estimate would be $6.5 trillion.

This is runaway risk with no international regulatory system in place.

Now Zero Hedge claims the Federal Reserve bailed out the world. In a way, that's very true.

But what if the opposite happened and the Federal Reserve did not step in and be the lender of last resort?

How would that have affected the U.S. economy? While what the Federal Reserve did stinks and the fact we have global runaway risk with no oversight really stinks and even worse, the world has no clue on how this all interacts smells to high heaven....

Do we know the real effects if the Federal Reserve did nothing?

Currently Zero Hedge is promoting the Grayson amendment. In Alan Grayson Seeks To Moderate Fed-Mandated Currency Swaps Which Bail Out Foreign Central Banks Shorting The Dollar:

We ignore the ethics of bailing out those who have done nothing but piggyback on the dollar carry trade, and in doing so, have decimated the purchasing power of America's working class, which is precisely what Ben Bernanke did.

I hear ya there. But Zero Hedge also notes if the amendment passes:

Watch for the dollar carry trade to implode immediately, as foreign CB's will know they can not rely on the Fed to pump them full of dollars when the margin calls come crashing in and there are no more dollars to be bought in the free market. As the BIS estimated: the total amount of potential dollar funding shortfall could be as high as $6 trillion. Take the Fed out of the equation, and you get just one word: panic.

Now this is of grave concern. What really happens if this dollar carry trade has immediate implosion?

Here is Rep. Alan Grayson introducing his amendment:

So, while I certainly applaud limiting foreign bank bail outs and U.S. taxpayer funds going overseas, a currency swap isn't just handing over cash. We do get foreign currency in exchange. It's quite clear the Federal Reserve put U.S. taxpayer money, through foreign exchange rates and potential losses, at risk, but what was the risk if the Federal Reserve had not become the lender of last resort?

Here is Rep. Grayson' trying to get to the bottom of these foreign currency swaps.

Our site names implies we are fire breathing Populists, very much interested in the United States being economically strong and especially fighting for working America, but frankly, I just do not understand the ramifications enough to know what kind of effect Grayson's amendment will have on the U.S. economy to know if it's a good idea or not.

I suppose if it's a good idea, then the members of the board of governors and the U.S. Treasury Secretary would approve...but on the other hand, do we really trust Geithner with anything at this point, never mind the board of Governors of the Federal Reserve?

More importantly, we have an amendment which might greatly affect global currency markets and us, the peanut gallery, the little guy, really don't have any idea on what kind of effect the Grayson amendment would have. It seems the only blog on the case, performing due diligence, is Zero Hedge.

See this post on the U.S. dollar being the mother of all carry trades.